New Relic Inc (NEWR) 2016 Q4 法說會逐字稿

Good afternoon. My name is Andrew, and I will be your conference operator today. At this time, I would like to welcome everyone to the New Relic fourth-quarter FY16 earnings conference call.

(Operator Instructions)

Thank you. Jon Parker, Senior Director of Strategic Finance and Investor Relations, you may begin your conference.

Thank you. Good afternoon, and welcome to New Relic's fourth-quarter and full-year FY16 earnings conference call.

Today's call is to provide you with information regarding our fourth-quarter FY16 performance in addition to our financial outlook for the first quarter and full FY17. Joining me today are New Relic's Founder and CEO, Lew Cirne; our President, Hilarie Koplow-McAdams; and our Chief Financial Officer, Mark Sachleben.

Today's conference call contains forward-looking statements. Any statement that refers expectations, projections, or other characterizations of future events, including financial projections and future market condition, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements.

For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the press release we issued today, as well as the risks described in our most recent Form 10-Q filed with the SEC, particularly in the section titled Risk Factors. Our commentary today will include non-GAAP financial measures.

We believe the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends, but note that these measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliation between GAAP non-GAAP metrics for our reported results can be found in our earnings press release issued today, a copy of which can be found on our website.

At times in our prepared comments or in responses your questions, we may offer incremental metrics to provide greater insight into the dynamics of our business or our quarterly results. Please be advised that this additional detail may be one-time in nature and we may or may not provide in update in the future on these metrics.

I encourage you to visit our investor relations website at ir.newrelic.com to access our earnings press release issued today, periodic SEC reports, a webcast replay of today's call, or to learn more about New Relic. Lastly, given it is our year-end call, we will be providing some additional one-time metrics today and publishing a supplemental earnings slide deck to our IR website shortly.

With that, let me turn the call over to Lew.

Thanks Jon, and good afternoon to everyone joining us today to review New Relic's fourth-quarter FY16 financial results. FY16, and Q4 in particular, mark significant milestones for our enterprise strategy. I'm going to jump right in with some impressive highlights.

In FY16, we grew our new enterprise monthly recurring revenue over 90%, and in Q4, added more enterprise new business than in SMB for the very first time. Coming into FY16, we had four customers paying us over $1 million a year. And now, just a year later, we have 15, several of whom are paying well over $1 million a year, and most are in multi-year commitments.

In terms of the breadth, we now have over 350 customers paying us over $100,000 a year, up roughly 75% from $200 million year ago. All told, we now have over 1,500 total enterprise paid business accounts. While we believe each of these can be $1-million-a-year customer, only 1% are today, which could lead us to a $1.5-billion-per-year opportunity just in the existing install base.

And finally, as our Q4 dollar-based net expansion rate hit a record 140%, it was north of 170% in the enterprise. Overall, this momentum helped us generate revenue of $181.3 million in FY16, up 64% year over year. Yet even as we just delivered this strong growth, we've made tremendous progress with our operating model, once again delivering 1,000 basis points of non-GAAP operating margin improvement versus the prior fiscal year, while for the first time achieving positive cash from operations for the full year.

The progress we are making is built on our focused vision and our execution against the key priorities that we share with all of you over the past year. Last quarter, we spoke about how our vision for New Relic is to be the first, best place to look for companies to understand our digital businesses.

Why is this so important to us? Because we're seeing our customers going through a dramatic transformation. The worlds of IT operations professionals, software developers, and digital business leaders are becoming more complex and interdependent than ever.

All of these constituents are trying to understand how their software -- that is, their business -- is performing. And to succeed they need to collaborate in a way that has never been in the past. From the digital storefront all the way back to the supply chain, businesses have a new way to a assess their performance through all of the software and infrastructure that is at the heart of their operations.

The result of this change is a demand for solutions that deliver well beyond what we think is possible from legacy application performance management tools. We are removing the walls between developers, operators, and execs to help our customers develop a shared understanding of their business. This results in hundreds of monthly active users at some of our largest customers, which we believe provide these corporations unprecedented visibility into the effectiveness of their digital experiences.

That vision is defining our approach to the two priorities we stated coming into FY16. One, continuing to execute on our multi-product software analytics vision, and two, driving further success in the enterprise while extending our leadership position in SMB. We believe we succeeded on both fronts, setting us up to gain further mind and wallet share in FY17.

From a perspective of developing our multi-product software analytics platform, we have seen very strong customer demand. I am thrilled to be able to say that all five of our paid products had record quarters, as roughly 30% of new monthly recurring revenue added in the quarter came from non-APM products. Just two years ago, less than 5% of our new business came from outside of APM.

Overall, over 25% of our customers now pay for more than one product. Importantly, even in transactions where a non-APM product is not part of the final purchase, we quite frequently see our non-APM product offerings as a deciding factor in that customer committing to a long-term partnership with New Relic.

We often talk about New Relic Insights in this regard, and it has certainly been critical to our overall success this year and traction within the enterprise. We believe that with Insights, our customers can gain unparalleled visibility into their own digital experience.

I was recently speaking with a Fortune 20 IT executive who expressed how Insights was a must-have tool for her as she tried to understand why one of her largest customers was having trouble with one of their SaaS products. Whereas APM offerings report on application performance and health in aggregate to help diagnose technical problems, Insight helps our customers collect and report on everything that touches their software.

It can uniquely service and address individual customer problems in real time. We believe this capability has not only been a game changer for that Fortune 20 exec, but also for all of our customers and prospects. I expect Insights, as well as our other on APM products, to continue to play a major role in our growth in FY17, but our work is not nearly finished.

Our customers have come to expect amazing innovation from us to help solve their most challenging problems, and we will continue to be focused on meeting their expectations as we grow our product portfolio. As it relates to our second priority, the evolution of our platform is a key driver behind the market's increase in the number of large enterprises standardizing on New Relic.

In fact, as I stated in the beginning, we grew new MRR from enterprise customers over 90% in FY16 compared to the prior year, and for the first time, added more overall new business in the enterprise than in SMB in Q4. Overall, our enterprise businesses zoomed to more than 40% of our recurring revenue base, as we're seeing great success in our goal to become the enterprise standard at many of the largest companies across the globe, companies like News Corp and GE, and most recently, Adobe, which standardized on New Relic this past quarter.

We increasingly see enterprises recognize the shortcomings of tools rooted in an on-premise or hosted approach, including the inability to cost-effectively scale, a more limited depth of visibility into the customer experience, and the lack of continuous innovation that a [cloud] solution like New Relic can deliver. As a 100% cloud-based multi-tenant solution, we are starting to see more companies choose New Relic, not only for the forward-thinking digital initiatives, but also their core IT operations use cases throughout the rest of the enterprise.

This recent trend substantially increases our opportunity and has led to larger deal sizes as we develop strategic relationships with CIOs. This was specifically the case in Q4 at a very large apparel manufacturer.

We had previously won the standard to monitor this company's billion-dollar digital business, but we were asked to compete for its central IT applications which help govern its mission-critical payment processing systems. This IT environment is comprised of legacy frameworks, and at the outset, the IT team had an on-premise bias for monitoring.

Six to 12 months ago, we may have shied away from this opportunity given a greater focus on digital initiatives, but we decided to pursue this opportunity to serve digital and IT together. This highly competitive evaluation, we were able to quickly and deeply instrument their environment and demonstrate the value of our unique cloud architecture at scale. As a result we won a seven-figure deal and their corporate standard, with more opportunities to pursue in the future.

Hilarie and Mark will have more to say about our go-to-market and financial priorities for FY17, but from my perspective, it comes back to our vision of being the first, best place to look for companies to understand their digital businesses. This entails increasing our ubiquity in the market, delivering even more innovation to our customers, and becoming the trusted enterprise standard.

Before turning it over to Hilarie, I want to also add how thrilled I am to have announced last week that we added two highly experienced software veterans, Sohaib Abbasi and James Tolonen, to our Board. These two bring rich experiences from Informatica, Business Objects, and Oracle, among other companies, and I expect their leadership and expertise to be critical in helping us further scale the business.

With that, I will turn it over to Hilarie.

Thanks, Lew. It was a really encouraging finish to the year, with a number of firsts for the go-to-market organization. Most notable was our enterprise new business outpacing SMB for the first time, which I believe reaffirms that our investment in the enterprise segment is the right one.

We saw over 90% growth in the number of six-figure-plus transactions for the year, and we achieved a great milestone, crossing through 1,500 enterprise paid business accounts. Overall, we now count over 40% of the Fortune 100 as customers, and both our new and total enterprise business grew by more than 90% year over year in FY16, increasingly driven by the type of standardization that Lew mentioned earlier.

We still see a huge opportunity ahead of us. In giving great returns we are seeing in our enterprise investments, we will continue adding meaningful capacity moving into FY17. In the quarter we saw new or add-on business with some fantastic enterprise companies, including Cisco, Dunkin' Brands, LinkedIn, Norwegian Cruise Lines, Rakuten, and Unilever, clearly a diverse set of companies, cutting across retail, leisure, tech, and CPG.

Within SMB, we had a great quarter in our mid-market business in particular, once again breaking a record for our largest transaction to date. In addition to this deal, we conducted business with great organizations like the nonprofit Kiva, PointClickCare, and Xero, among others.

Like past calls, we wanted to dig in to do a couple examples from this quarter on how diverse companies are leveraging our platform. Lew mentioned a great standardization decision in Q4, Adobe, a customer we've mentioned on past earnings calls. Adobe is a poster child for migrating to the cloud, going through a multi-year journey to replatform as a cloud-first company.

We were thrilled to expand our relationship with Adobe as it standardizes on New Relic to gain deeper visibility into the customer experience across its cloud offerings. Among the key differentiators we've heard from Adobe and other customers were benefits such as our true multi-tenant SaaS platform, breath of platform coverage, and analytics-first approach.

Another customer we grew our partnership with in the quarter was Under Armour. Under Armour is a great example of a company committed to building innovative digital technologies to help drive its brand, mission, and growth. It wanted further insights and capabilities beyond their homegrown monitoring tools to scale with their speed of growth.

As a result, they've turned to New Relic to help understand what is happening inside its e-commerce platforms as well as its Connected Fitness applications, recognizing our cutting-edge language support and breadth-of-platform capabilities. Under Armour's e-commerce unit is utilizing New Relic to help manage a rapid and complex migration from on premise to a cloud-based infrastructure, leveraging APM's browser and synthetics to help focus on creating and optimizing the ultimate customer experience for its engaged community of athletes. At Connected Fitness, New Relic is being used to help its engineering team rapidly innovate on new features and the end-user experience, and in the process, satisfying current subscribers and driving new customer adoptions.

Lastly, I'm thrilled to talk about Concur, another great win in the quarter. Concur and SAP Company joined the New Relic family this past quarter to gain better visibility into the business transactions of its private cloud-based services that make it simple to manage travel and spend. They realize that their current solution would not suffice for the type and scale of data analytics the business required.

Concur is now starting to leverage the entire New Relic Software Analytics Cloud as its primary platform for optimizing top revenue-generating applications and services, like Concur Travel & Expense, as well as TripIt. At the same time, they are gaining more visibility into end-user experience by monitoring the entire stack from the customer to the supporting back end. We are so excited to be partnering with them.

Last quarter I spoke about a couple of our early priorities as we look into FY17. One of these was optimizing our current product offering to help expand our market opportunity. We introduced Essentials as a promotion in the middle of Q4 to help cost-efficiently capture what our work has suggested is a more price-sensitive greenfield opportunity at the lower end of the market.

We have been pleased by its initial traction and contribution towards bringing more customers into the New Relic franchise. As a result, we're taking the promotional tag off as we begin FY17.

Looking ahead, we expect to continue various pricing pilots, particularly as it relates to customers' cloud-based environments where we recognize all hosts are not created equally. We believe there may be an opportunity for us to unlock an even greater TAM, particularly in SMB, through pricing is it is better aligned to how companies run their applications in the cloud and which would be complementary to our existing host-based pricing.

As it relates to other priorities in FY17, within both SMB and enterprise, we are starting to greatly increase our international presence, but in a highly focused manner. We recently brought on a seasoned leader to run our European enterprise business and expect to significantly boost our capacity there this year, as well as Australia, where we just invested local headcount this year. We believe this added presence should help improve our coverage as we look to grow our existing relationships and bring new companies into our franchise.

To support this growth both domestically and abroad, we're continuing to evolve our marketing strategy and optimize our marketing investments. As an example, for those fans of America's national pastime, you might've recently seen our new agreement with Major League Baseball. I'm incredibly excited about this groundbreaking partnership with MLB, which gives us the opportunity to share how MLBAM is leveraging New Relic on their mission to modernize the baseball experience for fans.

Another meaningful initiative for us this year is deepening our partnership with Amazon Web Services. As we have said on past earnings calls, we believe the move to AWS and other public cloud vendors is a significant tailwind for our business. In FY17, we will be working even more closely with Amazon.

In fact, last month, we joined on to their AWS Global Summit series, which will visit more than a dozen cities around the world. We believe that New Relic is unique in delivering unparalleled visibility into on-premise and cloud-based workloads on AWS, and customers are realizing how New Relic can make this transition seamless and provide multi-cloud and hybrid visibility in an increasingly heterogeneous IT world.

To sum up, I'm thrilled with the progress we made against our key initiatives in FY16. As we move into FY17, as Lew said, we remain focused on increasing our ubiquity in the market, delivering more innovation to our customers, and becoming the enterprise standard. With that, I'll turn it over to Mark.

Thanks, Hilarie. I will start today by reviewing the results of our fourth fiscal quarter before offering for guidance for our first quarter and FY17.

Turning to the financials, for our fourth fiscal quarter, revenue was $52.5 million, up to 57% year over year and up 10% sequentially. We ended the fourth fiscal quarter with 13,518 total paid business accounts. Of these, the total number of customers paying us more than $5,000 per year reached 5,887, up approximately 31% year over year.

As such, our annualized revenue per average paid business account continued to grow, coming in over $15,700, up 37% year over year and 7% sequentially. As Lew stated, for the quarter we experienced a dollar-based net expansion rate of roughly 140%, the highest figure we've reported publicly to date, and which gives us confidence a long-term payback of our investment in our go-to-market activities.

While this continues to be an excellent indicator of strong customer satisfaction and the power of our model, we remain focused on improving the mix between new and existing customers and expect that rate to moderate back to normalize levels in Q1 FY17. Having said, that we of over 1,500 enterprise customers, and we do not believe any of them is fully penetrated.

We continued to see success internationally in the quarter, as our non-US revenue grew to $17.1 million, up 53% year over year. Non-US revenue again represented 33% of revenue in the quarter.

Before moving to profit and loss items, I would like to point out that unless otherwise specified, all of the expense and profitability metrics I will be discussing going forward are non-GAAP results. A full reconciliation between historical GAAP and non-GAAP results can be found in our earnings press release issued today.

Gross margin for the quarter was 81%, unchanged versus last year and last quarter. With regard to operating expenses, we continue to invest in our go-to-market teams across all segments of the business. Our sales and marketing costs were $32.8 million, compared to $24.3 million for the year-ago period and $32.5 million in the third fiscal quarter of this year.

R&D expenses were $12.5 million in the quarter, compared to $6.5 million in the year-ago period and $10.5 million last quarter. R&D expenses were higher due to the expected timing of certain projects, which impacted the balance of what gets capitalized verse expense in the quarter.

G&A costs were $8.3 million in the quarter, up from $6.5 million in the year-ago period and $6.9 million last quarter. The sequential increase was largely attributable to office expansion-related costs, the beginning of a new technology system implementation, and personnel-related expenses.

Overall, our expenses in the quarter produced an operating loss of $12 million, compared to a loss of $10.2 million for Q4 last year and $10.7 million for Q3 of this year. This resulted in a negative operating margin of 23% in the quarter, compared to negative 31% a year ago and negative 22% in the third quarter.

Our net loss per share for Q4 was $0.24, based upon a weighted average share count of 49.6 million. This compares to a net loss per share of $0.22 based upon a pro forma weighted average share count of 47 million in Q4 last year. Quickly running through our financials for the year, revenue was $181 million, up 64% over last year.

Gross margin was 81%, unchanged versus FY15. Operating margin was a loss of 23% verse a loss of 33% in FY15. Our net loss per share was $0.85, unchanged from a year ago.

Turning to our balance sheet, we ended the fourth fiscal quarter with $191.3 million of cash, cash equivalents, and short-term investments, unchanged from the end of the third fiscal quarter. Elsewhere on the balance sheet, our total deferred revenue grew to $74.7 million, up 156% year over year. As has been the case in past quarters, this growth was driven predominately by the annual billing terms of our enterprise customers and also by some mid-market accounts changing from monthly to quarterly or even annual invoicing.

As discussed previously, we continue to expect growth in our deferred revenue to meaningfully outpace revenue growth for the foreseeable future; however, while it is an indicator of the success we are having in pursuing larger enterprise accounts, we do not currently view it as a key metric or a reliable indicator of our underlying business due to the varying durations of our contracts and billing terms. In fact, with our average invoice duration now six months, up from 3.8 months a year ago, we expect that rate of change to begin to slow later this year, which could create some relative headwinds on our deferred revenue growth.

Of note our day sales outstanding adjusted for deferred revenue did increase rather meaningfully due to the timing of several larger deals and renewals closing in the quarter. We expect DSOs to return closer to historical levels in Q1, although given our traction in enterprise, we do expect DSOs to increase over time.

Turning to cash flow, we generated roughly $1 million of cash from operations in the quarter, down, as expected, from the third quarter, but improvement from last year's quarter. Cash from operations for the year was a positive $4 million, verse an outflow of $13.6 million in FY15.

Now, I will turn to our outlook for the first quarter FY17 and for the fiscal year as a whole. We are initiating our outlook as follows. For the first fiscal quarter ending June 30, we expect revenue to range from $56.2 million to $57.2 million, or growth of 47% to 50% year over year.

We expect a non-GAAP operating loss of $11.5 million to $12.5 million. This would lead to non-GAAP net loss per share in the range of $0.23 to $0.25 based upon a weighted average share count of 50.4 million. For the full FY17, we expect revenue to range from $248 million to a $253 million, or growth of 37% to 40% year over year.

We expect a non-GAAP operating loss of $31.5 million to $35.5 million. This would lead to a non-GAAP loss per share in the range of $0.61 to $0.69 based upon a weighted average count of 51.6 million.

To reiterate from last quarter, we expect to achieve operating income breakeven on a non-GAAP basis by the fourth quarter of FY18. When modeling expenses from a seasonality perspective, we expect less Q2 to Q3 seasonality within sales and marketing this year.

Unlike in the past few years where we had one significant customer conference in the third quarter, we will be transitioning to a series of more intimate event starting in the second quarter in New York and London, culminating with a larger event in San Francisco in the third quarter. Additionally, as we stated last quarter, we expect a fairly steep improvement in our operating loss throughout the year, as we expect the majority of our hiring to take place in the first half of the year, and we have two significant system [implementations] in progress that should start phasing out in the second half.

From a cash flow perspective, we expect to be operating cash flow positive for the full year FY17, although there could be some deviations in the first half of the year. We currently expect free cash flow to find us cash operations, minus CapEx, minus capitalized software, to be negative for FY17 as a whole, but we expected to become sustainably positive by the end of FY18.

For the year we expect CapEx to be roughly $32 million to $34 million as we continue to invest in our world-class cloud infrastructure, we add additional office space in San Francisco, and we expand in Portland. We currently expect CapEx will start to ramp up in Q1 and peak in Q3. Despite these investments, we now believe our gross margin should remain around 80% in FY17.

With that, we're happy to turn it over to your questions.

Thanks, Mark. And actually, just before we start the Q&A, a reminder for those of you who may have joined the call late, we have a supplemental earnings deck available now on our IR website rehashing some of the key metrics from the prepared remarks since we know there were a lot of them.

Now I'll turn it over to Q&A, operator.

(Operator Instructions)

Sanjit Singh, Morgan Stanley.

Thank you, guys, for taking the question. This is actually Keith Weiss sitting in for Sanjit. Very nice quarter, and very nice end to FY16.

When we look at the outlook for FY17, the opening question is how should we think about the balance between the initiatives to better target SMBs with some of the new pricing metrics and the ability to re-accelerate customer base expansion versus the continued efforts to expand out the size of the customers themselves? It's like a price-versus-quantity equation. When we're looking at what's going to drive the growth in the top line, how much of it comes from customer base expansion versus how much comes from improving the monetization per customer?

Thanks for the question, Keith. This is Lew. I will take that one. Mark may have his comments as well.

First off, I think it's great that we have a balanced business where we've got a healthy SMB business that we've had really since the Company's founding, and as evidenced by the metrics we shared, our enterprise business is doing very well and growing very rapidly. So our SMB business is more mature now, and we're very pleased with where it's at. Its now a profitable business for us, and it's continuing to grow nicely, so we're going to continue to develop that business.

But as we look at the long-term unit economics, we really like what we see in our enterprise business. For example the dollar net expansion rate being so healthy in the enterprise segment. So that's why we are investing the way we are an enterprise.

We want to see continual balance in there. The SMB business is not only a healthy business for us, but it also keeps us sharp on the product, makes sure it's simple, and it keeps us -- it gives us a view into the where the rest of the market might be going as SMB often are the first to adopt technologies like cloud and other emerging standardizations.

Got it. If I could squeeze in a follow-up on that net expansion rate, you talked about 140% net dollar expansion rate, the highest that we've seen from the Company. It seems like part of the explanation is the shift toward the enterprise business and these enterprises have a more fulsome net dollar expansion rate.

So two questions in that. One, is that the primary driver of why the net expansion rate is so high? And if so, why should it normalize back down if the business is shifting significantly towards enterprise or continues to shift towards enterprise?

Keith, this is Mark. The move to the enterprise is the primary reason the number has gone up to 140%, and that's been driving that generally higher over the last couple quarters, and we've seen that shift. The enterprises, with our model, the land and expand and standardize, they come in and over time, they love the product, and they definitely expand, and so were seeing great numbers there.

I think in coming in Q4 that end of our fiscal year, it's a logical time to get a lot of expansion business in and then as we begin the beginning of the year, I think that just the way with the comp plans and the way we work, because we'll inevitably focus a little bit more on more on new customer acquisition in the first couple quarters, and then you crescendo toward the expansion deals toward the end of the year, so I think that has an impact on the numbers overall. And I just think over time, we do believe that number is going to -- we're not going to continue to accelerate the growth of that number like we have for the last couple quarters.

Got it. Actually very helpful. Thank you.

Greg McDowell, JMP Securities.

Great. Thank you very much. I wanted to ask about the impressive metrics around the non-APM products. Could you just expand a little bit on whether or not you're now able to lead with products like Insights even before APM, and just talk a little bit about -- you mentioned one-quarter of your customers are now paying for more than one product, as you think about FY17, where that percentage of customers using more can -- where that number could potentially go? Thanks.

Greg, this is Hilarie. I'm happy to take the first part of the question. What we see the customers is often they come to us with a question that follows squarely in the old APM space, and we quickly brought in the discussion with them to the performance of their user experience, which is really our browser offering or synthetics offering. And then ultimately, every time we engage with the customer, we talk about our Insights or analytics offering, and that's really where we are squarely winning these opportunities with customers because we can marry a performance experience to a business outcome, and that's the big lightbulb moment for our customers.

So as it relates to why are we seeing the attach rate so high, I think they fully recognize, and you hear it in the stores that we're telling about the standardization decisions, that we really have a platform that can make them more effective in their digital experience. And so looking forward, we expect that that rate will continue to grow. But every customer has a season in which they progress across our platform, and so I can't really predict if it's going to accelerate. What I can tell you is it's resonating with the market, as you can see from the very strong attach rates across each of the products.

Great. Thank you. One quick follow-up for Mark. Your FY17 guidance implies, as you mentioned, almost a third year in a row of 1,000-basis-point improvement in operating margin, so obviously, some clear leverage in the model. And I was just wondering, as you think about the longer-term operating model of the business, if you are thinking about potentially achieving that longer-term model faster than you originally anticipated when you went public. Thanks.

Sure. I originally -- I don't think we've talked about when we -- a timeline to get to that model, so I'm checking a little bit. We have aggressive targets out there. It will be the third year in a row which we've improved margins by 1,000 basis points. We continue to see good leverage in the model, and so we're going to do the work towards that.

We have talked about our cash flow and profitability outlooks through FY18 on the call. Beyond that, we're not really going to talk much. But we continue to be focused on growing the top line, and at the same time, we continue to focus on improvements in efficiency and improving the market.

Thank you.

Michael Turits, Raymond James.

Thanks. Sorry. Mute. Lew especially talked about selling into cloud and possibly some new price models there. What you think of as the long-term economics of selling into the cloud? How are they different, and how are you working through the with AWS?

First of all, we see AWS as an incredible tailwind for our business. Every time I meet with a Fortune CEO, it's a top of mind for them. They're thinking about it strategically.

And when they're thinking about strategically about adopting cloud, that forces them to reevaluate the tools and the vendors they've historically done business with, have been geared towards an on-premise world. So that's great for us.

What we're learning from our customers is that we should always be thinking about ways to make it even easier to consume New Relic products. And so Amazon, in particular, has innovated a lot in that area, and we've also seen Microsoft and Google present similar approaches to how they price.

Se we are always thinking about ways to be easier and easier to consume for our customers, and the more friction we reduce in how you become a New Relic customer, the better for our business over the long term, particularly for customers' adoption of cloud, where we really feel like we have a fundamental advantage.

Okay. If I could get on other one in at the other end of the spectrum, I think this is among the first times that you've really spent a lot of time talking about, I'm going to use the word legacy displacement or core IT.

What's changed there that you want to target that opportunity? What languages are you using that you are monitoring? Has Java done that? And how are you getting in? Is that go to market and the economics any different?

It's really exciting for us because it correlates with larger deal sizes, and certainly, that's evident in some of the numbers we shared today. How it comes about is, over the last several quarters, we've been increasingly pulled into these standardization discussions. We've had so much success in digital initiatives often within the business units where we have hundreds of people using our product that word gets out that there's this great product called New Relic that they should consider for other workloads, typically Java, sometimes dot net, and often in a hosted environment.

Where we were a year ago was simply we were so early in developing our enterprise go-to-market force, we didn't have the coverage to really fully address that opportunity. And while we're continuing to grow out that force, now we have enough coverage to say we're going to pursue those opportunities, particularly when we see them as standardization opportunities, and we are really pleased with our win rate. So by applying some focus and discipline where we're tackling platforms like SAP or like IBM on the Java stack and having success doing that in concert with monitoring other workloads that might be running in the cloud and servicing direct-to-consumer applications.

Okay, Lew. Great.

Sterling Auty, JPMorgan.

Thanks. Hi, guys. I also wanted to follow up on the conversation you had about the win that included both digital and traditional IT. How much of that was multi-product and the feature functionality that you bring to bear versus, was there any component that was really price sensitive, and given your value proposition, that that was key to the win?

I wouldn't call it price sensitivity, but I would call it compelling TCO advantage. I remember one standardization discussion where they had quickly had concluded they needed New Relic Insights and that big data approach, and then when they did back-of-the-napkin math on how they might try it with an alternative solution, it became prohibitively expensive to deploy, much less run and manage.

So we do have a fundamental advantage with our cloud approach. Insights plays a large part of it, but having the whole product portfolio is absolutely a key part of why we're winning in these standardization decisions.

But it really -- what discounts many of the other players is just how far we are ahead in cloud environments, which is increasingly critical to these customers. And then they say, well, New Relic also does a great job with these on-premise and little bit older applications as well, so it's that nice balance across the portfolio that's really resonating.

If I could add a little bit --

Great. And she talks about -- Sorry. Go ahead.

I wanted to add a little bit of color to that. If you think about the digital experience where we were a year ago, that was where we were primarily playing, that's really a front-office customer-facing experience. What we've noticed is a lot of customers are savvy to the fact that their back-office systems relate to that front-office experience. And we really are the only providers that can marry those two systems.

So when Lew -- if you think about these front-office digital experiences, you think about these back-office systems, and then a shift to the cloud, we're really the only provider out there that can provide full visibility to what is now the digital customer experience. I think that's what gave us great advantage in these larger standardization pursuits, and that's what the customer really recognized.

Great. Thanks. I think for the this is the first time I heard you talk about the profitability by segment, SMB versus enterprise. Are you managing the two businesses along those structures, and is that dictating how you're allocating some of the sales resources, obviously, enterprise being the core focus, but just curious if that's the mechanism you're managing it by?

Yes, we've always thought about segment-based economics, and really since I arrived at the Company two years ago, and we saw the opportunity to look at the segments, understanding that there are different drivers and different resource allocation models that play well. We've been really focused on our enterprise expansion, so of course, the bulk of our incremental resources have been focused there. But we also saw that we had some leverage points in SMB.

And we do manage them differently. We measure them differently. We think about lifetime value. But we have strong growth goals associated with each of these segments. Mark, anything to add?

No. I would say that certainly informs the way we invest, and what we go after. And we want to continue to grow both segments. We want to continue to grow the SMB segment in a profitable manner.

Great. Thank you guys.

Jesse Hulsing, Goldman Sachs.

You have Frank Robinson on for Jesse Hulsing. To start, you've talked a lot about Insights, but in thinking about what drove the surge in up-sell activity in the quarter, are there any other products that are doing better than others?

What was great about the quarter from my perspective was that every product had a record quarter, all five SKUs. So when we talk about the software analytics platform, what we mean by that is these five products all built on a common platform database technology, all delivered by the cloud, that work well together and leverage off each other. So we don't think it makes sense to have one product to measure the customer experience of what's going on in the browser and then another product measuring what's going on in the applications, the tier in the backend, and then another product trying to make sense of it in real time and analytics.

Like for example, one of our customers is a travel company, and they use Insight to look at ticketing activity second by second in real time, seeing how many tickets are flowing through the site, and in the same dashboard, they're showing how fast the page [moves] are and how fast the server time is. And they've proven beyond a shadow of a doubt that for their business, a slowdown in their application dramatically impacts their business in terms of ticket sales.

So the reason why all five products had a record quarter is because these belong together on the same architecture in the same platform. They belong from a cloud-delivered SaaS architecture, and that's why we have such a strong advantage.

Great. And looking at the guidance for next year, the 1,000 basis points of margin expansion, sounds like you think gross margin will stay relatively flat, and it sounds like you also plan to continue to invest in R&D and sales and marketing. But over the last two years, sales and marketing as a percent of revenues come down about 1,000 basis points. Should we see the same leverage in sales and marketing, or are you expecting most of the leverage to be coming from G&A?

No. I agree that the primary leverage will continue to be in the sales and marketing. We want to continue to invest in R&D. We've been a product-first company. We've talked about that a lot. We expect to continue to be. But we have some opportunities to improve in G&A, but then primarily in sales and marketing.

Great. Thanks.

Brent Thill, UBS.

Hey, guys. This is Michael Turrin on for Brent today. Just want to go back and talk a little bit about the customer adds. A lot of good metrics given on this call. We look at the -- we've talked a little bit about the deceleration and the customer adds as you add to more meaningful clients and focus on greater revenue-generating opportunities.

When we look at the customer count number, greater than 5,000, we see a little bit of a slowdown there as well, and maybe 5,000 is not the right number now given the fact that the average revenue per paid account continues to go up. So just wondering if you can help talk through some of the puts and takes and what might the right way to think about growth and customer adds and trajectory going forward.

First of all, we're really pleased with the customer add number in the quarter. It was nice to see that number go up to 392. And it is nice that our customers over 5,000 grew, what is it, about 35% year over year. Those are all healthy metrics.

And you bring up a good point that our average our average spend per account is growing really, really fast. So this is just -- we picked the number 5,000 as a new metric to introduce a while ago, and quite frankly, we're pleasantly surprised at how quickly our average spend is eclipsing that. So who knows if it's the right threshold in the long term, but that's what we're reporting for the foreseeable future.

I'd say we always need to have a highly balance between cost effectively acquiring the right customers, delighting them so that they continue to be customers, and then increase their investment in New Relic while maintaining healthy gross margins. Those are the essential elements of building a healthy business, and we want to that in SMB, and we want to do that in enterprise.

I think there is more work to be done there. I'm encouraged that that Essentials experiment we did last quarter certainly resonated with the low-end segment of the market that was a little more price sensitive. That's not the last experiment we will run. You can expect us to continue to try new ways to reach more customers. But it's more of on delighting them after they become customers that's going to be the real key to our long-term success.

Great. Thanks Lew. Maybe one for Mark. I appreciate the color on the deferred revenue. I know that's been a tough one for us to model. I wanted to revisit -- you talked about potential for slowdown as we progress through the next year, and just a little bit more, if there's anything on the size of the customer base that remains on monthly billings and how much we might see of the transition there still.

Well, we talked in the script about -- and in earlier text about that going, and close -- little bit -- around six months now. So I think there's still some room to go in terms of getting that up from six months, and so that will still have an impact on growing deferred. But obviously, the slowdown will continue to happen.

We're getting to the point where we're more mature. Our enterprise deals generally come in with an annual upfront payment term, which is great. On the low end, we still have a lot of customers that pay monthly, so there will still be quite a mix. We are migrating more toward the annual, and as I said, I think that six months is going to increase, but certainly, it's not going to go up another 2 1/2 months like it did in the last year.

Great. Thanks for taking my questions.

Ryan Hutchinson, Guggenheim.

Okay, great. That actually was one of my questions on duration, so that makes sense.

Shifting gears, you spent a lot of time in your prepared remarks talking about seeing more business in the enterprise versus SMB. Can you provide a little more color there in terms of how much more it was and then what the expectations are for the split between the two as we look out 12 to 24 months? And then I have a follow-up.

We are very pleased with the investments we've been making in enterprise and were paying off. And as we talked about for the first quarter ever, we had a greater incremental contribution in the quarter from enterprise than SMB. And enterprise is grown a year or so ago in the 34% to 35% range. We mentioned that it was about 40% last quarter.

So we expect that to continue to increase. Over time, we think that's going to be more than half our business, but we're not putting an explicit timeframe on that.

Okay. And then maybe just as a follow-up to that, the 1,500 enterprise customers, talking about them not being fully penetrated, what percent do you think could become fully penetrated in the timeframe there?

Well, the timeframe is really hard to predict, and if we could, I don't know how much we'd disclose today. I think $1 million a year is a small price to pay to ensure your digital business initiatives are successful.

You think about what's the competitive advantage of a modern bank today. It's the quality of the mobile experience, right? You want to measure everything about that and all your other software offerings.

So I don't think of $1 million a year as peaking out an account, and in fact, our average spend for our top 15 customers that spend more than $1 million year, it's well above the $ 1million a year. So that's why I believe -- we've got work to do to make sure our customers understand that full value, and we've got to deliver it, and then we can't take that for granted it's just going to happen. But that opportunity is in front of us, and we're going to pursue it.

Okay. And a quick clarification. The CapEx, going up quite a bit, to more than double year over year. Does that trend back to more normal levels in 2018? Just for modeling purposes and free cash flow?

Yes, we generally expect that will happen.

This is Jon. One thing I did want to point out on a couple of questions is that guidance for CapEx does exclude capitalized software costs, so the $32 million to $34 million is property and equipment, does not include capitalized software, just to be clear.

Okay, great. Thanks, guys.

Ben McFadden, Pacific Crest.

Hey, guys. Thanks for taking my questions. You mentioned on the call that you are having success on the backend IT systems. I wanted to start with a question on a follow-up to a topic that was brought up at the analyst day, I think actually by Jim, regarding 1/4 of the users being from IT operations and 1/4 of the users being business or executive users. Just bigger picture, as we look out a year, how much of new bookings do you think could potentially be coming from these two other categories?

That's a good question. I don't think we're prepared to give numerical guidance for that. The key thing is, all three of these constituents matter, and they all need to be served by the same product.

What's different in our business today from, say, a year ago, was how well our story is resonating with the IT ops team. I think that what that correlates with is how IT offices now recognizing cloud is an opportunity, not a threat. So now they are getting excited about how they can be more strategic for their company by really making their adoption of cloud successful.

And so now they are very interested in vendors and technologies that helps their clouded adoption strategy, derisk it, make it more successful, make it work faster and better. So that mindset change in our customer base is correlated with more focus on our end to delight that constituent because they've got hard jobs and a lot of hard work to do, and they also happen to have pretty healthy budgets to allocate to being successful.

Great. And then Mark, just a question on the model here. You mentioned, or you guided to positive operating cash flow for the year, but you said it could be volatile from quarter to quarter. Just you had two straight quarters of positive operating cash flow. How should we think about linearity of cash flow throughout the year, especially given the fact of the larger duration of the deals, that you are entering into, the bigger deals that you are entering into?

Generally speaking, I think that the first half will be a little bit more volatile than the second half. I think in general, you can assume that it should be going up over the course of the year. I think that the biggest volatility will come in next quarter.

Great. Thank you.

Scott Zeller, Needham.

Hi. Thanks. Two questions. The first is housekeeping. I think you mentioned on this call that you ended the quarter with 350 customers paying over $100,000 per year. Was there a number given last quarter for over $100,000 paying customers?

No. We've given that periodically, but we did not give that last quarter.

Okay.

We said over 200 at the end of -- at the analyst day, I think we said over 300.

Okay. And the second question was regarding the -- there have been a few comments about going after legacy on-prem-type displacements, The question is, is it inevitable that this happens? Because you are moving upstream, you're doing more enterprise work. It's probably very hard to avoid that.

Well, it can attract an opportunity we are getting pulled into. So we feel like it lines up well with our product and our product strategy, and it's leveraging the great work we've done, and it's a nice adjacency. What was missing from our -- the missing piece of the puzzle really was coverage and focus in the field.

And when we saw these CIO-driven opportunities coming into our pipeline, we decided to pursue these opportunities. Inevitable is a strong word, but we are excited about that opportunity, and we think it's another element of our growth of opportunity.

Great. Thank you.

George Iwanyc, Oppenheimer.

Thank you for taking my question. Just following up on the enterprise tractions you are seeing, can you give us an update on the competitive environment and whether you are seeing more pushback from the traditional vendors there, and any update on the type of pricing you're seeing?

The composition of the competitive landscape is really unchanged, as is the frequency with which we see a given competitor. As a reminder, from what we've said in the past, 90% of the transactions we do, do not have a listed competitor. But as you can imagine, the larger the deal size, the more attractive that is to multiple vendors, and so it's an increasing portion of the large deals we see.

What I'm really encouraged by is the trajectory we are seeing in our win rate and our confidence to compete for any deal, really. And in the case that we cited with an IT operations team that came in with a bias for on premise, but we quickly demonstrated how much more powerful our SaaS delivery was and how no other provider, whether they claimed SaaS or didn't, really could come close to doing what we did, particularly on the analytics side. That's an encouraging trend for us.

So we like how we're competing right now, but we are never done with that. The goal I'm laying out for New Relic is we went market-dominating product that we're going to be delivering this year. So we've got a lot more work to do because you can never take anything for granted.

There are no further questions at this time. Thanks again for joining us today. This concludes today's conference call. You may now disconnect.